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Dynamics and monetary policy in a fair wage model of the business cycle

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  • de la Croix, David
  • de Walque, Gregory
  • Wouters, Raf

Abstract

We first build a fair wage model in which effort varies over the business cycle. This mechanism decreases the need for other sources of sluggishness to explain the observed high inflation persistence. Second, we confront empirically our fair wage model with a New Keynesian model based on the standard assumption of monopolistic competition in the labor market. We show that, in terms of overall fit, the fair wage model outperforms the New Keynesian one. The extension of the fair wage model with lagged wage is judged insignificant by the data, but the extension based on a rent sharing argument including firm’s productivity gains in the fair wage is not. Looking at the implications for monetary policy, we conclude that the additional trade-off problem created by the inefficient real wage behavior significantly affect nominal interest rates and inflation outcomes. JEL Classification: E4, E5

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0780.

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Date of creation: Jul 2007
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Handle: RePEc:ecb:ecbwps:20070780

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Keywords: efficiency wage; effort; Inflation persistence; monetary policy;

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Cited by:
  1. Jean-Pierre DANTHINE & André KURMANN, 2007. "The Business Cycle Implications of Reciprocity in Labor Relations," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 07.12, Université de Lausanne, Faculté des HEC, DEEP.
  2. Lechthaler, Wolfgang & Merkl, Christian & Snower, Dennis J., 2008. "Monetary Persistence and the Labor Market: A New Perspective," IZA Discussion Papers 3513, Institute for the Study of Labor (IZA).
  3. Dennis Wesselbaum, 2013. "Reciprocity and matching frictions," International Review of Economics, Springer, vol. 60(3), pages 247-268, September.
  4. Gerhard Rünstler, . "Shirking, Endogenous Lay-off Rates and the A-cyclicality of the Real Wage," WIFO Working Papers 350, WIFO.

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